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Friday, February 09, 2007

Microeconomics quiz of the week

From the WSJ's professorjounrnal-dot-com:
"There are at least three ways to look at President Bush's energy initiative. One is knee-jerk: If Mr. Bush proposed it, it must be stupid. A second is to pretend you're king: How would I solve this problem? A third is to ask: Given the administration's stated conviction that markets know best, does the proposal make sense and go far enough? Partisan critics do the first. Academics do the second. Let's try the third." The issue is that at current oil prices, Americans use too much energy. The determination "too much" stems from the negative externalities of burning fossil fuels. "The economists' user guide to policy says the most efficient response to a market price that doesn't fully reflect the costs of consuming a good - in this case, the risk to national security and to life on Earth as we know it - is a tax.... A tax would raise the price of oil or gasoline or carbon, discourage consumption of gasoline and create incentives to produce alternatives. The market, not the government, would pick the best alternative." This week's Capital column reports that the Bush administration's aversion to tax increases has led the President to look for other solutions to the externality problem. The administration has proposed chosen to force Americans to use less gasoline and to use something else - notably more corn-based ethanol. The column then evaluates the gasoline tax, corn-based ethanol tax credit, and tariffs on sugar-based ethanol imports in the context of the of the legislated required ethanol production. The related articles report on the logistics of transporting ethanol from production facilities to consumers and the soaring imports of biofuels.

QUESTIONS:
1.) In a perfectly competitive market, suppose the market price of a good does not reflect the cost of consuming a good. Is there an externality of consuming the good?

2.) Why is a tax the most efficient response to a market price that does not fully reflect the cost of consuming a good?

3.) What action is the Bush administration taking to reduce the consumption of gasoline? Why is the Bush administration averse to increasing taxes?

4.) Should the Bush administration proposed a decrease in the gasoline tax and a reduction of the tariff on imported biofuels?

Reviewed By: James Dearden, Lehigh University

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